Market Outlook for FY27 Remains Uncertain Amid Rising Energy Prices, Warns Industry Analyst

Market Uncertainty Ahead: India's FY27 Outlook Remains Challenging

The Indian stock market's performance in FY26 was marked by a decline in large and small cap segments, while the midcap index delivered single-digit returns. According to Krishnan VR, head of quantitative research at Marcellus Investment Managers, this performance was reasonable given the high valuation base in late 2024 and the disruptions caused by tariffs, fiscal and monetary loosening, and the energy shock due to the Iran war.

Krishnan attributes the increased return dispersion across stocks and the decline in market breadth to the disruptions caused by the Iran war. However, domestic SIP flows have held up well, countering the heavy selling by foreign investors and smoothing out market volatility to some extent.

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The outlook for FY27 remains challenging due to global uncertainty, particularly the US-Iran war. Krishnan notes that it is difficult to predict the market outlook for FY27, but assuming the war situation and energy prices normalize quickly, it would be reasonable to expect better returns in FY27 as valuations at the aggregate market level now look more reasonable after the 10% year-to-date correction.

However, if the disruption to energy supply and higher prices persist, the knock-on effects on FY27 earnings growth will be visible over the year. To navigate these challenges, investors can consider investing through SIP or STP to average down their purchase price or rebalance their portfolio. A wait-and-watch, quality-first approach is still warranted for domestic equities, given the scale of disruption to India's oil and gas supply and attendant impact on inflation and energy costs.

Krishnan recommends considering strong businesses available at reasonable valuations within healthcare, pharma, export-led manufacturing names, and broader financial services. Diversification into global equities should also be considered, given the lack of enough opportunities within Indian equities currently to play certain themes like AI, high-end manufacturing, among others.

The recent geopolitical conflicts and crude oil price volatility have deteriorated India's macroeconomic outlook, raising growth and inflation risks. India imports nearly 80% of its energy requirements, making nearly every sector affected either directly due to higher energy costs or indirectly due to higher freight and packaging costs. The risks of imported inflation have increased with the rupee having depreciated around 10% against the dollar over the last year.

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The Reserve Bank of India (RBI) could tighten monetary policy stance if inflation increases over the coming months, and especially if there is no resolution to the conflict over the next month or so. If the government chooses to bear most of the impact of higher oil prices by reducing excise duty or any other such measure, then there is a risk of fiscal slippages.

The IT sector is expected to be cautious, with investors advised to be careful about exposure to BPO or pure software development, as these are among the few areas which can be disrupted relatively easily by current Gen-AI systems. The market will be wary of the terminal value of most IT services business models, and investors should not be anchored by historical valuations.

The defence sector presents a mixed picture, with increased defence capital spend and focus on indigenisation appearing to be structural multi-year themes. However, valuations of many companies in the sector are still stretched, and a cautious, valuation-aware approach is warranted due to the longer gestation periods of defence projects.